Accounting

What is Accruals?

Accruals are expenses you've incurred but haven't been invoiced for yet. Recording them ensures accurate profit calculation.

Example

You used £500 of electricity in March but won't get the bill until April. You accrue £500 expense in March.

Key Dates

Calculate at year end for accurate accounts

How Accruals Works in Practice

Accruals are a fundamental concept in accrual accounting (as opposed to cash accounting). An accrual is an expense or income that has been incurred or earned during a period but has not yet been invoiced or received in cash. By recording accruals, you ensure that your profit and loss statement reflects the true cost of running the business in each period, regardless of when the cash changes hands. This is known as the 'matching principle' -- expenses are matched to the period in which the related revenue is earned.

The most common accruals are expense accruals. For example, your electricity bill covers January to March, but you do not receive the bill until April. At your year end on 31 March, you would accrue the estimated electricity cost for the quarter so that it appears in the correct accounting period. Without this accrual, your profit would be overstated for the period ending 31 March and understated for the following period.

Income accruals (also called 'accrued income') work in reverse. If you have completed work for a client in March but will not invoice until April, you record accrued income in March. This ensures the revenue appears in the period the work was performed. On the balance sheet, accrued income appears as a current asset.

Accruals are particularly important at the year end because they directly affect your reported profit and therefore your tax liability. An expense accrual reduces profit (and thus Corporation Tax), while an income accrual increases it. HMRC expects accounts to be prepared on an accruals basis for Corporation Tax purposes (with limited exceptions for very small businesses that may use cash basis accounting). Getting your accruals right ensures you pay the correct amount of tax -- neither too much nor too little.

Step by Step

At the end of each accounting period (typically the year end, but also at month end for management accounts), you review all known expenses that relate to the period but have not yet been invoiced. For each one, you estimate the cost and record a journal entry: debit the expense account (increasing the cost in the P&L) and credit 'accruals' or 'accrued expenses' (a current liability on the balance sheet).

In the following period, when the actual invoice arrives, you reverse the accrual and record the real invoice. This is usually done by posting a reversing journal at the start of the new period, then processing the invoice normally. If the actual amount differs from the estimate, the difference is absorbed in the new period.

For example: you estimate your March electricity at £500. You debit utility expenses £500 and credit accruals £500. In April, the actual bill arrives at £520. The reversal removes the £500 accrual, and the full £520 invoice is recorded. The net effect is £500 in the March period and £20 in the April period.

Common items to accrue at year end include: utility bills, rent if paid in arrears, interest on loans, audit and accountancy fees, staff bonuses declared but not yet paid, and any services received but not yet invoiced.

Practical Tips

Create a year-end accruals checklist covering common items: accountancy fees, utility bills, staff bonuses, interest charges, and any recurring services received but not yet billed
If you prepare monthly management accounts, accrue material expenses each month to get an accurate picture of profitability -- do not wait until the year end
Use your previous year's accruals list as a starting point each year to ensure you do not miss recurring items
Set your accounting software to auto-reverse accrual journals at the start of the next period to prevent double-counting

Common Mistakes to Avoid

Forgetting to accrue for year-end expenses like accountancy fees, resulting in understated costs and overstated profit
Not reversing accruals in the following period, leading to double-counting when the actual invoice arrives
Estimating accruals poorly -- while exact figures are not always possible, estimates should be reasonable and based on available information
Confusing accruals with prepayments -- accruals are expenses incurred but not yet paid, while prepayments are expenses paid but not yet incurred

Frequently Asked Questions

What is the difference between accruals and accounts payable?

Accounts payable (creditors) are amounts you owe where you have already received an invoice. Accruals are amounts you owe where you have not yet received an invoice but have already received the goods or services. Both are liabilities on the balance sheet.

Do I need to accrue for small amounts?

Materiality applies. If the amount is trivial relative to your business size, it is acceptable to ignore it. However, for year-end accounts and Corporation Tax purposes, you should accrue for any amounts that could meaningfully affect the reported profit.

Can accruals reduce my tax bill?

Yes, expense accruals increase your costs in the period, which reduces taxable profit and therefore Corporation Tax. For example, accruing £2,000 for your accountancy fee at year end reduces your taxable profit by £2,000, saving £500 in Corporation Tax at 25%.

What is accrual accounting versus cash accounting?

Accrual accounting records income and expenses when they are earned or incurred, regardless of cash movement. Cash accounting records them only when cash is received or paid. Most limited companies must use accrual accounting for their statutory accounts and Corporation Tax return.

Source: HMRC Business Income Manual (BIM31000+) on accounting principles: https://www.gov.uk/hmrc-internal-manuals/business-income-manual/bim31000 and International Accounting Standard IAS 1 (Presentation of Financial Statements)

Related Terms

Prepayments

Prepayments are expenses you've paid in advance for something you'll receive in the future. They're assets until the benefit is received.

Accounts Payable (Creditors)

Accounts payable is money your company owes to suppliers and others. Also called creditors or trade creditors.

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